An unusual approach to consultant compensation

When done right, stock options can be a useful tool for compensating independent contractors

Over the last few years there has been a lot of talk about the value of employers providing stock option plans to employees and the favourable treatment these plans receive from the Canada Customs and Revenue Agency (CCRA).

However there has been very little discussion on the benefits of using stock options to compensate contractors and skilled independent consultants in lieu of money. It was commonly believed that by paying independent consultants in stock options CCRA would consider them employees. But this is not necessarily the case.

And although the poor performance of stock markets of late may suggest the appeal of stock options is not what it once was, organizations should explore this alternative form of compensation as a strategy for both good times and bad.

It was not that long ago we heard daily about Generation X workers who had just graduated and were putting in 100-hour workweeks for some startup company. After a few years, the company went public and over night the lucky few found themselves able to retire comfortably for life.

This is the lure of company stock options. It seems like a lifetime ago since January 2000 when the Dow Jones peaked at 11,722 points and March 2000 when the Nasdaq reached its all-time high of 5,048. But don’t mistake a slump in stock prices for a reduction of their value as part of a compensation strategy.

One thing history has taught about the movement of stock prices over the last century is that the downs are temporary and the ups are permanent.

Furthermore, those who embrace stock options as a portion of their compensation believe the options in your company will be successful and want to enjoy in your company’s success.

When the job market for hi-tech workers was tight in the late 1990s, paying in stock options allowed companies to get access to top talent at below market prices. This same logic applies now when the Canadian economy is soft, companies that trade their potential future stock value in options are able to gain the skills of highly paid consultants today at a lower cost.

Including stock options as an independent consultant’s compensation from the employer’s point of view will not only solidify the relationship with contractors, if structured properly, stock options have no financial risk.

There are no tax consequences to either the employer or the consultant as long as the options are not exercised because the options have no value until the consultant sells them. CCRA considers paying independent consultants in stock options as a form of barter at the time they are issued. If a company is considering offering stock options to its independent consultants it should be particularly cautious however that the relationship is one of hiring an independent consultant not an employee.

CCRA applies four tests to determine the status of an independent consultant and it is important that these are met.

•To what extent does the independent consultant control how the work is done?

•Does the independent consultant own the tools?

•Does the independent consultant pass the integration test?

•What are the chances of profit and loss for the independent consultant?

To ensure CCRA does not interpret stock options for contractors as proof of an employer-employee relationship, the options issued to the independent consultant should be in the name of the consultant’s incorporated company not to the consultant personally. The consultant is able to defer both taxes and share in future growth in value of the company which might be of greater value than what the company can afford to pay the independent consultant now.

An example where a consultant may choose stock options rather than immediate cash compensation would be where the consultant has created a technology for a company and rather than selling it or licensing, the consultant takes stock options and shares in the risk and the gain when the company becomes successful.

All stock option documentation specific to the independent consultant should be excluded from stock option documents for the company’s employee stock option plan. This means companies choosing to pay stock options to independent consultants should make sure that their stock option plans for full-time employees are legally segregated from one another so CCRA will rule them as two different programs.

Over the last few years, the legislation regulating stock options as compensation for employment in Canada have been in flux. For example, several budgets ago, the federal Liberal government started allowing employees to defer taxes on exercise options, valued up to $100,000 per year if the employee did not sell the underlying stocks.

It is highly recommended before considering this type of payment plan for your independent consultants that all parties involved to seek the advice of a labour and employment lawyer.

Peter Merrick is a certified financial planner and a group benefit specialist working with both employers and individuals. To request a free copy of “CCRA’s Employee or Self-Employed Guide” outlining CCRAs test to determine self-employment status contact [email protected], (416) 677-6611 or www.petermerrick.ca.

To read the full story, login below.

Not a subscriber?

Start your subscription today!